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United States Trade Representative (USTR) Robert Lighthizer in a detailed 182-page document has accused China of indulging in unfair trade practices. This report, commonly known as Section 301, served as the basis for initiating punitive trade measures against China. Since then, there has been an accentuation in imposition of tariffs on goods imported from China. Also, there is an equal and swift retaliation from China against US imports. Amid this action-reaction pattern, world markets are suffering from capital outflows and currency weakness which policymakers associate with hike in interest-rate by the US.
Economists do not restrain from predicting the end results of this war. Broadly, there are two schools of thought that are logically projecting their thoughts in favour of China or the US. Proponents of China’s win argue that tax cuts introduced by the US last year have already taken its fiscal deficit sky high and a trade war will call for additional investment by the US (to compensate for cheap imports), thereby stressing the need for additional imported capital thus, intensifying the fiscal deficit.
Also, the increase in US tariffs will turn its exports costly and render them less competitive. It will lead to an increase in inflation and a subsequent fall in dollar’s exchange rate. In this case, Fed is likely to raise interest rates, thereby weakening again the cycle of investment, growth and employment.
On the contrary, the advocates believing US ‘thriving’ the trade war suggest that multinational companies that have set up production centres in China will find it difficult to source cheap inputs from China, owing to the imposition of retaliatory tariffs and reduced exports to the US. It will lead to a cutback in production and loss of confidence, which may trigger recession. Whatever be the outcomes of this war, it has made international trade more uncertain and turned geographical borders a hard nut to crack.
Amidst this, it is apprehended that Chinese multinational companies, in order to survive, may look forward to sell its products in a big market like India. Hence, the Indian Government proactively swung into action and increased import duties on 328 textile products by up to 20%. It shot two birds with one stone i.e. controlling the foreign exchange from going out and sustain the textile sector, the second largest employer after agriculture.
In June, the RBI hiked interest rates to contain inflation and arrest the outflow of foreign currency (keeping India the preferred destination for foreign investment) vis-à-vis the rising interest rates in the US. However, both these measures may be seen as a makeshift arrangement for calming down the depreciating rupee which recently breached Rs 70 per dollar, mitigating higher oil price obligations rather than stabilising the economy. This dosage is not only undersized, but also misdirected as the economy is bleeding domestically. The Nikkei India Manufacturing Purchasing Managers Index (PMI) showed that business sentiment was at its weakest since October 2017, though there is reasonable growth.
Clearly, it reflects that the sentiments of common businessmen for continuing their businesses are incompatible with the ongoing conditions, but relentless growth of few businesses has taken the overall growth up. These trends can also be mapped with the booming Indian stock market (Sensex scaling a record 38000 point recently) and plummeting GDP estimates.
Pertinently, Moody’s (May 2018) and the IMF (July 2018) reduced their projections for GDP growth of India to 7.3% in 2018 from their earlier estimates of 7.5%. With the given facts and figures, it is not difficult to understand that policies like demonetisation and GST by the NDA government remained catastrophic for small businesses. Where demonetisation led to the closure of several small-scale businesses for many weeks, GST has given a free market across India to the big businessmen, taking away the natural protection offered by the state governments to the small businesses in the form of customs, entry tax, purchase tax etc. Further, no cash refunds on GST paid under the composition scheme to small and medium businesses have tilted the benefits in favour of big businesses. This explanation may further be extended to understand the increasing unemployment in the country.
In a nutshell, efforts to offer respite to the bleeding economy through monetary policy instruments are half-baked. There is need to keep wobbly the fiscal deficit for some time and create public investment so that confidence of the small businessmen is revived. Once the cycle of investment is ignited (small and medium businesses), it will boost employment, thereby rendering additional purchasing power and consumption. Domestically produced cheap goods can also be exported (if the rupee value remain down) to earn foreign exchange.
The critics may argue that public investment may promote inflation as it did in 2008-09, but if the wealth is not stashed in safe havens abroad, it would help to build strong macroeconomic fundamentals. Reports have highlighted that arbitrary reduction in deposits in Swiss banks by Indians is either due to the escalation in giving up Indian citizenship by the depositors or re-routing of the money to Switzerland by creating bogus “front” companies in other parts of the world.
The need is to arrest the flow of black money to other countries of the world and tax it in a way that tax proceeds are used for public investment.
The ongoing trade war can be a curse for others, but it can be converted into a blessing by adopting pro-people policies by the Indian Government.